When you apply for a mortgage, lenders use four pillars to measure your finances and put together a loan suited to your purpose. Your credit, debt, income and assets play integral equal roles in lenders’ eyes. Let’s break down the nuts and bolts of what lenders want to see on loan applications, and how working within these four pillars may help you find a mortgage to suit you, even if your situation isn’t “perfect.”
The credit score is the best-known financial barometer to predict a borrower’s future likelihood of default. Of course, you’re not planning to get a mortgage to subsequently go delinquent, but lenders nevertheless use it to measure your payment predictability. Lenders want a credit score of at least 620 or better. Beyond the credit score is the credit report, which reveals details about your past and current financial habits. Mortgage companies consider delinquent payment patterns a red flag — including old collections of all kinds, past-due balances even on accounts that are no longer active. Expect an inquisition on such accounts.
So what if you have a previous bankruptcy, foreclosure, short sale or loan modification? What if more than one of these events exist in your credit history? Again, fear not, but do be prepared to answer all questions regarding such events. If you have supporting documentation, provide it to your mortgage broker upfront. Generally, even today you can still get a mortgage just a few years out of one or more of these credit events. Most commonly, there’s a three-year wait time for government financing (i.e., FHA) and seven years on conventional financing (with the exception of a short sale — the waiting time is now four years). The most recent date is considered if one or more such credit events exist in your credit history.
Active trade lines (meaning open credit) are another lending hot button. You’ll need to have at least two forms of open and available credit that you use regularly – that doesn’t necessarily mean carrying a balance, but it does mean you need to show credit activity. Unfortunately, gone are the days of using alternative forms of credit, like a cell phone bill or a cable bill, in lieu of credit report trade line.
Checking your credit in advance of applying for a mortgage can give you time to work through any issues, or to take time to work on your credit score if it needs to be higher. You can check your credit reports for free once a year from each of the three credit reporting agencies, and you can see two of your credit scores for free on Credit.com.
A lender wants to see every single minimum payment obligation you have – whether or not it’s on your credit report — independent of your general household expenses.
The typical forms of debt a lender must account for when determining how much mortgage you can afford are: any form of car payment, minimum payments on credit cards, student loans, personal loans installment loans, alimony or child support, garnishments and IRS debt.
This seems simple enough, but sometimes the way a debt is listed on your credit report can cause a problem. Let’s take a common example: Student loans. You may have multiple student loans through one creditor, and they are all listed out on your credit report that way, but you make one monthly payment to that creditor for the multiple loans. The fix: You’ll need to provide your mortgage broker a payment letter from the creditor identifying what loans are included with the student loan creditor and the amount of your monthly payment.
Another common issue is co-signed loans – specifically, loans someone else took out that you co-signed. In order for the other party’s debt to not hurt your mortgage application, you’ll need to provide documentation that the other person is making the payment directly to the creditor and has been since either the inception of the loan or the most recent 12 months. This is usually accomplished with bank statements or canceled checks. Reducing your debt load is immensely beneficial when trying to qualify for a loan.
Lenders must be able to show that your income supports your proposed mortgage payment plus your other debt payments. If your debt, including the proposed mortgage payment, exceeds 45% of your income, you may need to look for less house, borrow less money, or pay off some of your debts to improve your numbers.
When it comes your income history, lenders like to see a minimum two-year period of working in the same or a similar field. Don’t have it? That’s OK. Make sure you explain this to the lender in writing, and be sure include any occupational gaps. If you’re an hourly wage earner, expect your banker to average your year-to-date income. If you’re salaried, it will be much more transparent in terms of qualifying because typically a salary is a more stable form of income.
The down payment amount you have can dictate the loan program and ultimately how much mortgage you can handle. Assets include both funds for a down payment as well as savings in the bank post-closing of escrow. Mortgage brokers, banks and lenders expect to see two to six months of savings post-closing, and at least 3.5% of the purchase price for down payment. If you have access to funds that aren’t yours, gift money, for example, is a viable alternative, just be sure provide the full paper trail in any exchanging of funds.
*Mortgage tip: When buying a single family home, your full down payment funds can be gifted.
If you’ve been told that you can’t get approved for a mortgage, get a second opinion — perhaps even a third or fourth. Make sure to disclose all the pertinent known facts about your financial situation. A quality professional will ask you to provide details on the who, how, what, when, where and why — which can help make your quirky financial picture much more cohesive and thus more likely to get you approved for a mortgage.